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Optimal macroprudential policy and rational bubbles

Xavier Freixas and David Perez-Reyna ()

Journal of Financial Intermediation, 2021, vol. 46, issue C

Abstract: We provide a microfounded framework for the welfare analysis of macroprudential policy within a model of rational bubbles. For this, we posit an overlapping generation model where productivity and credit supply are subject to random shocks. We find that when real interest rates are lower than the rate of growth, credit financed bubbles may be welfare improving because of their role as a buffer in channeling excessive credit supply and inefficient investment at the firms’ level, but their sudden price decrease may cause a systemic crisis. Therefore, a well designed macroprudential policy plays a key role in improving efficiency while preserving financial stability. Our theoretical framework allows us to compare the efficiency of alternative macroprudential policies. Contrarily to conventional wisdom, we show that macroprudential policy (i) may be efficient even in the absence of systemic risk, (ii) has to be contingent on productivity shocks and (iii) must be contingent upon the level of real interest rates.

Keywords: Bank; bubble; macroprudential regulation; E44; E60; G18; G21; G28 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.jfi.2021.100908

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